Overconfidence, Arbitrage, and Equilibrium Asset Pricing

This paper offers a model in which asset prices reflect both covariance risk and misperceptions of firms' prospects, and in
which arbitrageurs trade against mispricing. In equilibrium, expected returns are linearly related to both risk and mispricing
measures (e.g., fundamental/price ratios). With many securities, mispricing of idiosyncratic value components diminishes but
systematic mispricing does not. The theory offers untested empirical implications about volume, volatility, fundamental/price
ratios, and mean returns, and is consistent with several empirical findings. These include the ability of fundamental/price
ratios and market value to forecast returns, and the domination of beta by these variables in some studies.